Keeping up with the Euro crisis

Keeping up with the saga of the Euro area crisis is becoming as confusing as watching every third episode of a spy series with a revolving cast.

Today the Germans voted to put extra funds into the 'bail out' fund for defaulting Euro members. Most people think this is nowhere near enough.

The Commission have proposed a tax on all financial transactions to create a 50 billion Euro fund to help pay for the bailout. But the British will never agree to this as it means the UK will be paying to prop up a currency they never joined.

The Euro was never an 'optimal currency area' and as the late Professor Pearce said 'It will never work'. Despite the best, if reluctant, efforts the Euro will probably not survive.

The BBC understand your angst at this long and drawn out affair and have produced a Q&A on the latest IMF/G20/EU proposal. This includes proposals to let Greece partially default which is seen as inevitable now.

The BBC Q&A is here

Operation Twist - Probably misinterpreted

I know this post is challenging and is aimed at A2 students only. However it is a very important recent development in monetary policy.

The Federal Reserve has undertaken a restructuring of the debt it holds in an attempt to lower long term interest rates. This has become known as 'Operation Twist', but this is mainly because people want more.

The Fed has tried to lower long term interest rates by causing an excess of demand in the market for long term government debt. This is done by withdrawing from the market long term debt by buying it themselves. Such government debt is an important part of many investment funds portfolios, for example pension funds.

As a result there is less long dated government debt on the market and so the price of the remaining debt is bid up. A government bond pays the holder a fixed amount each year, say $2 for each $100 of the face value of the bond.

As the price of the government debt rises then the annual payment made by the government to the holder of a bond is a lower percentage of the market price. This means long term interest rates are lower. For example a $100 bond pays $2 a year. The market price of the bond is forced up t0 $200 and so the $2 paid now represents a rate of interest of just 1%.

So the Fed have tried to buy up long term bonds, taking them off the market, and replacing them with short term bonds. This will hopefully reduce the rates on all long term loans and so stimulate, for example, mortgage borrowing. This would encourage a recovery in the housing market which remains crucial in the USA.

The markets have taken this as a sign of panic. This has not helped confidence, hence the plunge in the stock markets. The markets also wanted more Quantitative Easing as they feel the economy needs a bigger boost.

I am far less clear on the Fed's motives. There was a time when central banks structured the debt in a way that was consistent with the interest rate set. Having more short term bonds on the market certainly increases the liquidity of the market and most commentators seemed to have missed this.

This is an unusual move by the Fed. It has been, at best, badly received and at worst seen as a sign that the policy options have run out. Most economists also doubt that the move will actually be effective.

The Guardian explains 'Operation Twist' here

Dr Death suggests Greece default on its' debts

Dr Roubini (Dr Death) is renowned as one of the world's most pessimist Economists and has been credited with predicting the Global Financial Crisis in 2008. He has suggested that Greece default on their debt and leave the Euro.

His justification for this is because of advantage of floating exchange rates. He states that if Greece leaves the Euro and returns to the Drachma then they would be in a stronger position to recover. This is because a return to the Drachma would lead to a dramatic depreciation of the currency. This depreciation would improve competitiveness and growth.

A depreciation of a currency will make exports cheaper and imports more expensive therefore improving conditions for local producers. He also examines the success of Argentina and Iceland after they defaulted in 2001 and 2008 respectively to successfully recover.

His article is here

Markets need information to work properly

We know that free markets allocate scarce resources efficiently. But the key point here is that they are 'free' with full information on both sides of the exchange.

Lots of things can make markets fail to work properly. Two are monopoly power and a lack of information on one side (asymmetric information). Governments work to try to avoid such issues and the Competition Commission and the Office of Fair Trading (OFT) exist to protect consumers.

The OFT is going to investigate the charges made to holidaymakers to convert pounds into foreign currency. The problems of lack of information and monopoly power exist here. People don't really understand the service they are paying or the costs involved. Also financial institutions are able to lock in their own customers to their services and also exploit the lack of information because of a lack of competition between banks.

The BBC explain the issue and a 'Super complaint' by 'Consumer Focus' to the OFT in the article below.

For Deps consider the information a market needs to work well and reduce the issue of scarcity through specialization and exchange. Grecians should consider this from the point of view of market failure that is involved in F581 and the issue of market failure that will arise in Transport Economics.

The BBC article is here

The problem of argricultural markets

I have never met a poor farmer, but I have never met one that didn't complain either. But they do have their cross to bear.

The problem of agricultural markets is that natural events cause good and bad years with no predictability and so farmers incomes are literally all over the place. Ironically the 'good years' for crop yields are the bad years for income.

Deps won't know the term 'inelastic' yet, but it means that demand does not vary much with price. In rich economies everyone has enough income to eat and when food prices fall they don't each much more. Equally when food prices rise people have to buy food and so demand does not go down much either. So demand for food is 'inelastic'.

The result is that when there is a bumper crop farmers have to accept very much lower prices as supply expands. The quantity consumed goes up by less than the price falls and as a result consumers expenditure (farmers incomes) is less. In the diagram above the expenditure at price P2 and quantity Q2 is more than P1 Q1.

This is the situation Australian orange growers find themselves in. The rain and the sun arrived at exactly the right times, and so everyone has a good crop. There is no point letting the oranges rot on the tree and so all the farmers sell, raising supply in the market and lowering the price. The result, in this case, is a price lower than the costs of production.

This is one reason why so many countries intervene in agricultural markets. (Note this comes up in IB all the time.)

I suspect that the fools in IT continue to block the pictures, but I can't find a link to a picture that will show what I need you to see. So use your phone or ask Mr. Camburn to use his computer.

The Age explains the plight of the orange farmers here

EuroZone

The inability of Greece to meet the required targets and the rising expectation that Greece will default has brought about a huge amount of speculation of what will happen next. The Daily Mail expects the "EU to be torn apart", the Telegraph views it as an opportunity to start again and design an EU that Britain would like to join and the Guardian warns Great Britain that this is going to hurt.

The last prediction is why these developments are so important. This is because over half of Great Britain's trade is with to Europe. Economically the relationship between the EuroZone and the United Kingdom is extremely close. The attached graph further justifies the close relationship between the two economies.

Watch the following connections to get a full understanding of the issues revolving around a Greek default.

http://www.youtube.com/watch?v=rrsGSvuBAi4&feature=player_embedded

http://www.youtube.com/watch?v=m-fWgT26rzs&feature=player_embedded#!

Inflation rises to 4.5%

Worse than expected inflation figures have surfaced this week putting increasing pressure on the Bank of England to increase interest rates. These are very tough times with many predicting unemployment figures to rise further. The only good news coming from the article is the hope of inflation figures dropping by the end of 2012. Read the article below.

http://www.bbc.co.uk/news/business-14895510

Unemployment rises strongly

There is a problem with all policy choices. There is an inevitable trade off, one goal has to be sacrificed in order to achieve another.

While there have been periods when that really didn't seem too bad (such as the NICE decade), now the costs are transparent. In particular the aim of long run growth and securing a sound budget position is causing a rise in unemployment and the sacrifice of short-run growth.

The recent unemployment figures show this clearly and have inevitably led to a call for a reversal of policy. In this case the costs of the policy are unevenly distributed, those who loose their jobs pay the highest price and for some, the young, there is little prospect of a job anytime soon.

The BBC covers the story and have an excellent interactive map if you follow the links at the bottom of the page!

The BBC coverage is here

Another GDP growth downgrade

It looks all gloom!

Dr Archer added: "The current softness of the economy and anticipated GDP growth of one per cent in 2011 and 1.5 per cent in 2012 is particularly bad news for Chancellor George Osborne as it is substantially below the OBR's projections of 1.7 per cent growth in 2011 and 2.5 per cent in 2012 on which the Chancellor based his target of reducing the Public Sector Net Borrowing Requirement to £122 billion in fiscal 2011/12."

Read the full article below.

http://www.myfinances.co.uk/news/2011/09/13/oecd-expects-faster-uk-economic-slowdown

Times are getting tougher?

A recent IFS (Institute for Fiscal Studies) suggests that living standards will be at the lowest level in 30 years.

They stress that the next ten years the UK household budgets will be squeezed. It is suggested this will occur because of the impact of increasing taxes and government spending cuts. In other words it is the governments fault. What do you believe? Read the attached article and decide whether these severe consequences could be avoided. What is the government's motivation behind tightening fiscal policy? Why does the BBC article neglect to raise this issue?

The BBC cover the story here

London Riots highlight the failure of Capitalism

Before following the English press with calls for anarchy or a return to socialism it is important to examine the economic causes behind the riots. It has undoubtably been stimulated by some simply wanting to create havoc, however, could it also be a classic case of economic market failure illustrated through poor housing and lack of economic mobility? Is capitalist system failing minorities in London?

A fairly 'left field' view can be found here

The impact of policy

Everyone knows that times are tough. One of the issues that can't be avoided is that the recession led to a fall in output and that means someone has to be worse off.

The policy response of the government meant the recession was not as bad as it could have been, but the government debt that built up as a result is now an issue.

How to reduce the balance of the debt the government built up is a contentious subject. The Institute of Fiscal Studies has looked at the impact of the governments plan to reduce the debt. It is important to consider the distribution of the pain of the solution.

However some may say that the argument is pointless. If the government had not acted then the pain would have been much worse and unfairly distributed (the unemployed would take all the costs) and that there is little anyone can do except spread the pain acrosss more generations.

The Guardian report the IFS study here

Economists argue against 50% Tax on the Rich

Twenty Leading Economists have written to the government questioning the 50% tax for those earning over £150 000 per year.

They state the following:

We are concerned that Britain's 50p income tax rate is doing lasting damage to the UK economy. It gives the UK one of the highest personal tax regimes in the industrialised world, making it less competitive internationally and making us less attractive as a destination for both foreign investment and talented workers.

"It punishes wealth creation by imposing on entrepreneurs and business people a marginal tax rate in excess of 50 per cent once national insurance contributions are added in. This is particularly damaging when the UK needs to create new businesses in new industries."

"We call on the Government to drop the 50p tax at the earliest opportunity as part of a package of measures to stimulate growth. Only by returning to an internationally competitive tax regime will Britain enjoy long-term sustainable economic growth."

The Channel 4 news piece is here

Do you believe this is an appropriate strategy to reduce the budget deficit?

Reduced child-care support hurts the poor

Cuts to the working tax credit have hit poorer families. Four in 10 of those affected have considered giving up work because they will no longer earn enough to cover their childcare bills. The cut has added £500 extra on average to the childcare bill of low-income families.

Around 80 per cent of parents in low-income families who are in employment agreed with the statement: "Once I have paid for childcare, I am in a similar position to as if I was not working."

Parents spend almost a third of their incomes on childcare - more than anywhere else in the world, according to research by charities Save the Children and Daycare Trust.

The situation is even worse for families already living in poverty, where nearly half have had to cut back on food to afford childcare.

Please watch the Channel 4 video here

What impact is this having on society and how does it impact on social mobility?

A temporary solution?

Yesterday I looked at the arguments on the way UK fiscal policy should be deployed. The alternative short-term policy is to use monetary policy.

Usually monetary policy is about adjusting interest rates. This affects saving, borrowing and so consumption and investment behaviour. In short it pushes Aggregate Demand (the total amount of demand in the economy) up or down and so influences the level of economic activity.

The economic data suggests that the UK could slip into another recession. A more expansionary fiscal policy is ruled out (see yesterdays post) and so monetary policy might be an option. The problem is interest rates are already just 0.5% and so can't be lowered. The alternative is to simply print money.

Printing money in this context is called Quantitative Easing. The money supply rises, people have more money to spend and so consumption rises and firms have an incentive to invest. Easy really.

The problem is that printing money could be inflationary. That is unlikely, the money supply has not grown in the recession and the effect will likely go into demand. But another problem is that confidence among households and firms is so low that the extra money will simply be saved and have no impact on output.

The Monetary Policy Committee of the Bank of England meets today and will leave interest rates where they are. Some want them to do more Quantitative Easing (QE2). It probably wouldn't do any harm, but would confirm that the Bank fears the worst.

The Guardian covers the call for QE2 here

Stick or twist?

The debate on how to manage demand-side macroeconomic policy has been going on since Alistair Darling came up with Labour's deficit reduction plan. The Coalition government have decided to reduce the deficit faster and further than Labour wanted to.

The issue debated is how much support Britain's fragile economy needs to return to growth and how much damage increased levels of public debt would do.

Labour, on the whole, take the view that the government should be doing more to ease the short term pain of low growth, high unemployment and the danger of a new recession. So they urge a slower reduction in the deficit with the government doing more to boost Aggregate Demand.

The Coalition take the view that long term growth is more important and the burden of debt could reduce that significantly. They also point to the debt crisis in the PIIGS and say that creating such a debt crisis would be much worse. So they are happy with a lower stimulus to AD (it is still significant given the government deficit deficit) but the prospect of more secure long term growth.

You will find that differnet newspapers will take different views on this and many other issues. The Daily Telegraph is a supporter of the Coalition Policy and so run stories largely sympathetic to the government strategy. However the Guardian and Independent will be more critical and sympatetic to Labour's view. It is important you recognise bias when reading stories and stick to the economic, not the political, arguments.

The two stories below illustrate the sublte (sometimes not so subtle) differences when reporting the Chancellors speech here. Compare and contrast.

The Daily Telegraph article is here

The Guardian article is here

Scarcity, really?

The graph shows proven exploitable oil reserves rising from 1980 to 2003

It is often claimed that resources are scarce.

Worse still it is claimed resources are running out. This claim is especially often made for oil, but it has never really been true.

The polar caps are retreating and this is allowing us to access resources in remote areas. These resources, oil in this case, are now worth extracting because the price of oil is so high. Even if these resources were accessible in the 1970's no oil company could have profitably exploited them, but at $80 to $100 a barrel they can.

So does the fact that there is more and more oil being discovered mean oil is not scarce?

No, not at all. Because the oil resources of the Arctic have alternative uses it is scarce and commands a price. But oil is not as rare as it was, although using it all will be a real problem for global emissions.

The Guardian reports the great 'Polar oil rush' here

For those new to economics at CH

Some of you will have noticed that there is a useful links section on the bottom right of this blog. Close to the picture of Professor Pearce if you can't find it.

These links are shortcuts to useful websites. One of the most useful is the BBC 'UK economy' page. This provides plenty of data, interactive maps and often links to stories of current interest.

Have a look at this page and some of the others in the list to see what is available.

For those of you struggling with the CH filter all pictures will come out if viewed via your smartphone!

The BBC UK economy page is here

US economy will affect UK recovery

It was once said that if America sneezed then Europe caught a cold. The phrase was based on the power of the US economy as a buyer of European goods.

If America goes into recession their demand for imports falls. That means European exports fall and so demand falls and jobs are lost here. The UK's biggest trading partner is the USA and so the fact that the US created no jobs last month is worrying. It suggests the US economy is very much weaker than thought and could return to recession.

This is more of a cause for concern for the UK than for other EU countries as the business cycle of the UK is much more closely aligned to the US than it is to the EU. While that is changing (60% of the balance of trade is accounted for by EU trade) America remains a key power in the world economy, roughly equal in size to the whole of the EU in GDP terms.

External factors are more and more important to the way economies behave. No government can fool itself that it has all the policy answers to its own economic problems.

The Guardian cover the US jobs crisis here

The price of life?

Every year I look for a story that illustrates opportunity cost. This year I have recycled one from last summer. It is a classic one on how to best use the NHS's limited resources and comes from a decision of NICE (NICE decides which treatments should be available on the NHS).

There are many such tough decisions and this time it is a drug that helps those with late stage bowel cancer. This decision is to deny a drug to patients that will extend their life by six weeks to a few months. It costs £21,000 per patient.

The opportunity cost of allowing the drug for general use would be the treatments that could be funded instead. The article suggests 6500 patients could benefit a year. Thats £136.5 million a year available to patients who might live a lot longer.

This is not a pleasant decision for anyone to make. But it does bring home the real cost of a decision on resource use.

The BBC story is here

When regulation helps

It is the received view in economics that the best way to deal with market failure caused by negative externalities is a tradeable permit. When that can't be implemented a tax is second best and then regulation, which is better than doing nothing.

But sometimes the market needs a bit more help. This means regulation to force a change in behaviour. A classic case is noise limits on aircraft engines and another is banning the old fashioned lightbulb.

The EU has already banned the 100w bulb and now the manufacture and importation of the 60w bulb has followed. The article explains the savings to consumers of such action.

But if the energy saving alternatives are so much better and cheaper why haven't consumers switched themselves? The answer is imperfect information. Consumers see the very much cheaper old-style bulbs and opt for them, ignoring the ongoing lower running costs.

While an alternative would be education that would be far less effective and would not bring the lower carbon emissions needed to meet the 2020 targets.

The BBC explains the savings here